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Chapter 1—Introduction and Goals of the Firm

MULTIPLE CHOICE
1. The form of economics most relevant to managerial decision-making within the firm is:
a. macroeconomics
b. welfare economics
c. free-enterprise economics
d. microeconomics
e. none of the above
ANS: D PTS: 1
2. If one defines incremental cost as the change in total cost resulting from a decision, and incremental
revenue as the change in total revenue resulting from a decision, any business decision is profitable if:
a. it increases revenue more than costs or reduces costs more than revenue
b. it decreases some costs more than it increases others (assuming revenues remain constant)
c. it increases some revenues more than it decreases others (assuming costs remain constant)
d. all of the above
e. b and c only
ANS: D PTS: 1
3. In the shareholder wealth maximization model, the value of a firm's stock is equal to the present
value of all expected future ____ discounted at the stockholders' required rate of return.
a. profits (cash flows)
b. revenues
c. outlays
d. costs
e. investments
ANS: A PTS: 1
4. Which of the following statements concerning the shareholder wealth maximization model is (are)
true?
a. The timing of future profits is explicitly considered.
b. The model provides a conceptual basis for evaluating differential levels of risk.
c. The model is only valid for dividend-paying firms.
d. a and b
e. a, b, and c
ANS: D PTS: 1
5. According to the profit-maximization goal, the firm should attempt to maximize short-run profits since
there is too much uncertainty associated with long-run profits.
a. true
b. false
ANS: B PTS: 1

6. According to the innovation theory of profit, above-normal profits are necessary to compensate the
owners of the firm for the risk they assume when making their investments.
a. true
b. false

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ANS: B PTS: 1
7. According to the managerial efficiency theory of profit, above-normal profits can arise because of
high-quality managerial skills.
a. true
b. false
ANS: A PTS: 1
8. Which of the following (if any) is not a factor affecting the profit performance of firms:
a. differential risk
b. innovation
c. managerial skills
d. existence of monopoly power
e. all of the above are factors
ANS: E PTS: 1
9. Agency problems and costs are incurred whenever the owners of a firm delegate decision-making
authority to management.
a. true
b. false
ANS: A PTS: 1
10. Economic profit is defined as the difference between revenue and ____.
a. explicit cost
b. total economic cost
c. implicit cost
d. shareholder wealth
e. none of the above
ANS: B PTS: 1
11. Income tax payments are an example of ____.
a. implicit costs
b. explicit costs
c. normal return on investment
d. shareholder wealth
e. none of the above
ANS: B PTS: 1

12. Various executive compensation plans have been employed to motivate managers to make decisions
that maximize shareholder wealth. These include:
a. cash bonuses based on length of service with the firm
b. bonuses for resisting hostile takeovers
c. requiring officers to own stock in the company
d. large corporate staffs
e. a, b, and c only
ANS: C PTS: 1
13. The common factors that give rise to all principal-agent problems include the

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a. unobservability of some manager-agent action
b. presence of random disturbances in team production
c. the greater number of agents relative to the number of principals
d. a and b only
e. none of the above
ANS: D PTS: 1

14. The Saturn Corporation (once a division of GM) was permanently closed in 2009. What went wrong
with Saturn?
a. Saturn’s cars sold at prices higher than rivals Honda or Toyota, so they could not sell many cars.
b. Saturn sold cars below the prices of Honda or Toyota, earning a low 3% rate of return.
c. Saturn found that young buyers of Saturn automobiles were very loyal to Saturn and GM.
d. Saturn implemented a change management view that helped make first time Saturn purchasers
trade up to Buick or Cadillac.
e. all of the above

ANS: B PTS: 1

15. A Real Option Value is:

a. An option that been deflated by the cost of living index makes it a “real” option.
b. An opportunity cost of capital.
c. An opportunity to implement a new cost savings or revenue expansion activity that arises from
business plans that the managers adopt.
d. An objective function and a decision rule that comes from it.
e. Both a and b.

ANS: C PTS: 1

16. Which of the following will increase (V0), the shareholder wealth maximization model of the firm:
V0∙(shares outstanding) = t=1 ( t ) / (1+ke)t + Real Option Value.

a. Decrease the required rate of return (ke).

b. Decrease the stream of profits (t).
c. Decrease the number of periods from  to 10 periods.
d. Decrease the real option value.
e. All of the above.

ANS: A PTS: 1

17. The primary objective of a for-profit firm is to ___________.

a. maximize agency costs
b. minimize average cost
c. maximize total revenue
d. set output where total revenue equals total cost
e maximize shareholder value

ANS: E PTS: 1

18. Possible goals of Not-For-Profit (NFP) enterprises include all of the following EXCEPT:
a. maximize total costs

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b. maximize output, subject to a breakeven constraint
c. maximize the happiness of the administrators of the NFP enterprise
d. maximize the utility of the contributors
e. a. and c.

ANS: A PTS: 1

19. The flat-screen plasma TVs are selling extremely well. The originators of this technology are earning
higher profits. What theory of profit best reflects the performance of the plasma screen makers?
a. risk-bearing theory of profit
b. dynamic equilibrium theory of profit
c. innovation theory of profit
d. managerial efficiency theory of profit
e. stochastic optimization theory of profit

ANS: C PTS: 1

20. To reduce Agency Problems, executive compensation should be designed to:

a. create incentives so that managers act like owners of the firm.
b. avoid making the executives own shares in the company.
c. be an increasing function of the firm's expenses.
d. be an increasing function of the sales revenue received by the firm.
e. all of the above

ANS: A PTS: 1

21. Recently, the American Medical Association changed its recommendations on the frequency of pap-
smear exams for women. The new frequency recommendation was designed to address the family
histories of the patients. The optimal frequency should be where the marginal benefit of an additional
pap-test:
.a equals zero.
.b is greater than the marginal cost of the test
.c is lower than the marginal cost of an additional test
.d equals the marginal cost of the test
.e both a and b.

ANS: D PTS: 1

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